A Proper Solution to Capital Outflows
The recently issued guideline on further regulating outbound direct investment specifies sectors where outbound direct investment is encouraged and also tightens control of investment in the sectors of real estate, hotels, entertainment, sports and casinos.
The sectors where outbound investment is tightened or banned are hot spots pursued by Chinese capital in recent years. Some Chinese corporations show great interest in foreign soccer clubs and some European soccer clubs have already been purchased by Chinese investors, who do not hesitate to burn money to undertake such acquisitions.
Famous Chinese corporations seem “unfashionable” if they have made no overseas mergers and acquisitions (M&As). In fact, the government previously supported all types of overseas M&As made by Chinese investors, especially those in sectors restricted by the recent guideline. The stock markets and shareholders also welcomed such overseas business expansion because these investments indicated China is becoming economically powerful.
However, the process of globalization isn’t progressing smoothly.
On one hand, globalization still faces the obstacles of exchange rate wars, trade barriers and especially the new de-globalization policy by the United States, the world’s largest economy.
On the other hand, overseas M&As made by Chinese investors in the past show that the Western world is biased against Chinese corporations when reviewing M&A cases. Particularly, Chinese capital is often prohibited from entering hi-tech industries and high-end manufacturing industries in Europe and the United States in the name of national security.
Therefore the sectors Chinese capital has successfully entered are all industries where foreign governments encourage investment, while in the sectors involving core strategies of foreign countries, Chinese investment is rejected. The sectors restricted by the recent guideline are all beneficial to the host countries but unprofitable to China.
Chinese investors should learn the lesson of Japan in the 1980s and 1990s. During that time, Japanese investors undertook a large number of M&As worldwide, especially in the United States, which was concerned that the whole country would be purchased by Japanese businessmen.
Japanese investors helped the United States overcome business difficulties culturally in real estate and other industries, but after that the Japanese economy got into a long-lasting recession from which it has still not recovered.
Drawing from these lessons, China must avoid the situation where globalization just takes capital out of China, leaving debt inside the country. The shadow of the post-2008 financial crisis era seems to be leaving, and at this turning point, a policy-led siphon effect has formed in the United States, drawing capital from around the world. But the Trump administration does not support globalization of U.S. capital and even forces domestic companies to stay in the U.S. market with tax penalties.
As U.S. monetary policy returns to normal, emerging markets including China are mainly concerned about capital outflows caused by U.S. interest rate hikes. During the past several interest rate increases by the U.S. Federal Reserve, the Chinese yuan’s exchange rate fluctuated, causing turmoil in the China’s foreign exchange and stock markets. If China doesn’t restrain overseas M&As by Chinese corporations, there will be asset bubbles and financial crisis in China.
More importantly, some Chinese corporations use bank loans instead of their own capital to feverishly invest overseas, leading to extremely high debt ratios. Under such circumstances, outflow of Chinese capital will bring risks to China’s financial system.
For the ongoing supply-side reform, China needs to maintain stability of the entire financial system, the capital market and the real estate market. Therefore, unrestrained capital outflows must be stopped. Most other countries should do the same.
To curb irrational capital outflows, China must also provide better conditions for domestic capital, such as cutting business costs and providing a better investment and financing environment.